How do lenders protect their interests? This is a question that comes up frequently wherever banking courses are taught. We all know that the business of lending people money is a risky one. There is always the possibility of people borrowing money, and then disappearing – never to be see again. Then there is the possibility of lending people money, only for them to fail to repay because of unavoidable reasons such as illness. So, given these very real possibilities, how do lenders protect their interests? Well, there are some four key ways in which the lenders ensure that their interests are well protected.
Firstly, the lenders undertake lots of background checks, to ensure that they only lend money to people who are creditworthy. They look at things like a person’s borrowing and repayment history. They also look at a person’s earnings, a person’s financial commitments… and so on before making a decision on whether or not to lend him money. That is why, for instance, if you work at CVS, a lender may request to see your pay stubs, before lending you money. So you find yourself having to go to myhr.cvs.com login page, sign in, and proceed to download your paystubs. Then you present them to the lender: who goes through them, to see how much money you earn and what deductions you are liable for. And that ultimately informs the decision on whether lending you would be a good idea or not.
Secondly, the lenders often ask for collateral, to protect their interests. So you provide an asset, which would be auctioned in case you were unable to repay the loan.
Thirdly, the lenders often ask for guarantors, to further protect their interests. These provide guarantees, offering to be held responsible, in case you are unable to repay the loan.
Fourthly, the lenders often insure the loans that they give out. Or, in practice, the borrowers are asked to pay loan/mortgage insurance premiums — as part of the loan costs. Consequently, in case the borrowers are unable to repay the loans due to unavoidable reasons (such as illness or loss of jobs), the lenders are assured of getting something from the insurers. Therefore their interests are further protected in that way.